Competition Bikes Budget Analysis
There are several budget areas in Competitions Bikes year nine budget forecast that are areas for concern - Competition Bikes Budget Analysis introduction. The factory overhead budget for the year was budgeted at $481,798 less $150,000 depreciation. Total depreciation over the last three years has remained at $130,000 per year for the past three years as identified on the company’s balance sheets. Therefore setting depreciation at $150,000 for the 9th year is too high without identifying any new major purchases that would add to this depreciation.
Even though depreciation is not actual cash flow it does define the reduction of company assets and should be reported accurately. The cost of distribution network support needs to be adjusted. A distribution network is everything involved in getting the product from the manufacturer to the retailer. The estimated expense for year nine is $50,830 which is equal to the year eight dollar amount however, year nine forecasted 110 more units sold. The cost per unit of distribution network support is equal to $14. 95 when comparing the previous three years data.
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This meant the forecasted budget for an estimated 3510 units should be set to $52,474. 50. Executive and Administrative salaries have not changed for three years and are budgeted at $220,000 and $170,000 respectively. Not providing any raise for the employees at Competition Bikes could make employees feel unappreciated and devalued. Decrease morale causes performance to suffer, at such a critical time Competition Bikes cannot afford to have inefficient employees that are not at the top of their performance. Salaries for personnel in the Executive and Administrative areas should allot for a raise for year nine.
Utilities are budgeted for $150,000 for year nine. Between years six, seven, and eight, there are no consistencies between the increase on the cost of utilities however, there has been some increase each year. Reasons for this increase could be due to inflation or more energy consumption at the facilities due to a rise in manufacturing or other efforts. Between years eight and nine there is no forecasted increase in utilities cost as both years are set at $150,000. Year nine needs to forecast some kind of increase in utilities to compensate for inflation.
The Advertising budget is set to $28,412 for year nine which is just short of a $1,000 increase over year eight. With the economy the way it is and such a small improvement in sales forecasted for next year, Competition Bikes should put more money aside for advertising purposes. With professional riders’ sponsors not investing in purchasing bikes for their riders, Competition Bikes needs to find a way to appeal to the individual rider rather than their corporate sponsors. They could accomplish this by changing or adding to their advertising approach which will surely call for budget increase in that area.
Flexible Budget and Variances Competition Bikes had many variances in their Flexible Budget. Anticipated net sales dropped 3. 1% from 3510 units to 3400 units causing a loss of $164,450. This is an negative unfavorable variance because it causes the company to lose income and forces a need for adjustment across the budget to compensate for the loss of profit. Inaccurate sales forecasts weather more or less than anticipated offsets the entire budget for the year, sometimes forcing major adjustments across the board.
Variable Costs: Direct materials, direct labor, manufacturing overhead – variable, and variable selling expenses all dropped 3. 1% along with the total net sales. This is a favorable variance because it coincides with the drop in sales. All these expenses are directly related to product manufacturing and should adjust in line with total sales volume. Advertising expenses increased $2,838 or 10%, this expense is an unfavorable variance because Competition Bikes spent more money than originally budgeted resulting in a greater loss of gross profit.
It seems that the company late in the year could have adjusted their approach to spend more in advertising in order to make up for the lag in net sales, this reaction to a decrease in sales is likely and could have helped get the company up to 3400 units sold for the year if they noticed a decrease in anticipated sales earlier in the year. Competition Bikes should have increased their budget for total advertising expenses in year nine to appeal more to the individual buys rather than the corporate sponsors in order to meet their sales goals.
Transportation out was over budget by 2%, as with advertising expenses, anything over budget results in a loss of gross revenue for Competition Bikes. With a 3% decrease in total sales, there should have also been a 3% decrease in transportation out expenses as transportation out is a fixed delivery expense. Reasons for this unfavorable expense could be that Competition Bikes offered expedited delivery on certain order to promote sales or there may have been an increase in cost enforced by the company’s freight provider for delivery services.
Contribution Margin: The contribution margin dropped 3. 8% and is an unfavorable variance because, while total sales dropped 3. 1% the extra increase in other areas of variable spending caused the contribution margin to drop further than total sales dropped. Contribution margin is the amount of each unit sale that adds to total profit, Competition Bikes higher variable costs in advertising and transportation lowered the overall contribution margin. Fixed Manufacturing and Selling Expenses:
Depreciation and website creation and maintenance saw no change in the anticipated budget vs. he actual expense. Depreciation is divided over a period of years depending on what was purchased for use in the company and website creation and maintenance is a fixed expense that hasn’t changed for four years. Distribution network contract support should have been over budget this years due to the initial oversight in factoring in the increase in projected sales for the year. Because the actual sales for year nine are equal to that of year eight and the year eight expense was quoted in the budget, this expense has no change for the year.
Fixed General and Admin Expenses: All areas of fixed general and admin expenses remain unchanged from the original budgeted amount except for one area. The one change in this area lies in research and development which was under budget by $3,577 or 4%. This favorable expense adjusted slightly more than the drop in sales volumes which reduced the overall loss in gross profits. As far as fixed expenses are concerned, R&D is the most flexible and has adjusted accordingly in order to react to the loss in net sales.
Overall total operating expenses are at a favorable variance due to decrease in costs for research and development. Operating Income: Operating income dropped 57% or $45,820 in year nine resulting in a negative unfavorable variance. Operating income is the profit made by a company’s operations formulated by taking the gross income and subtracting operating expenses, depreciation, wages and cost of goods sold. Because total sales only dropped 3% this huge drop in operating income signifies that the company has been spending more money to provide fewer goods which results in the negative variance.
This results in a huge decrease in the company’s total worth which impacts investors decisions to keep or sell stock in the company. As the company stays public it needs to keep the consideration and views of its stakeholders in mind. Recommended Corrective Actions: Net Sales Forecast: A major unfavorable variance for year nine was net sales forecast. Things like the economy, customers, budget cuts, competition, and market shifts can make accurate sales forecasting difficult. Because of this Competition Bikes needs to take measures to ensure their forecasts are as accurate as possible.
First they should base their expected sales on the market they are targeting now. If the company wants to increase sales they should look to increase or adjust their target market and not just assume sales will go up as the economy improves. The company needs to evaluate why they did not meet their forecasted sales volumes for this year and identify what areas were over estimated; this could provide insight and valuable lessons learned in order to make the year ten forecast more accurate and achievable.
Evaluating sales history, what percentage of deals closed, assumptions about customers, and evaluating past sales forecasts will help Competition bikes accurately assess future sales forecasts. Advertising Expenses: Advertising expenses were over budget for year nine. Competition Bikes error was to assume that these expenses would remain the same from year eight. A new assessment needs to be made for year ten to identify what areas to focus their advertising and how advertising can assist with meeting sales goals and then adjust accordingly.
In order for business to grow, Competition Bikes needs to start operating differently and realize that it needs to move more into advertising rather than rely mainly on word of mouth for business growth. Transportation Out: Transportation out is a fixed 30$ per unit and should have dropped 3% along with net sales. Instead it jumped 2%. Competition Bikes needs to forecast extra money in their budget for rush orders and expedited deliveries in order to avoid overspending in their transportation services. Contribution Margin: Overspending in transportation and advertising caused the drop in contribution margin.
Correcting the budget as described above will correct the overall contribution margin. Operating Income: Operating income dropped a considerable amount in year nine. Competition Bikes needs to take a look at its operating expenses to ensure they are spending in the most efficient ways. Standardizing office supplies, computer equipment and buying as many items as possible in bulk will reduce expenses. Encouraging employees to conserve power and setting the thermostat higher in the summer and lower in the winter will save money in power and heating bills.
Reviewing contracts with suppliers and ensuring the company is getting the best price possible on materials will also provide opportunities to reduce spending and increase operating income. Applying Management by Exception to the Variances: “Management by exception (MBE) is a policy by which management devotes its time to investigating only those situations in which actual results differ significantly from planned results. ” (Hut, 2009).
The idea behind MBE is that mangers can spend their time dedicated to more important things like shaping company goals and trategy but get involved in other things when they need attention. The manger who manages by exception creates good conditions for accomplishing goals in the beginning and intervenes only when things become unfavorable. A Competition Bikes manager using Management by Exception would only analyze and pay attention to significant variances in the flexible budget. The manager would go through the flex budget, identify what items have a large variance and take action specific to the variance as related to the individual item.
Line items such as the 57% drop in operating income would gain attention from a manager using MBE because a major change or business reform would be necessary to correct this variance. Advertising expenses rose 10% in year nine and should be addressed using this policy in order to ensure that correct practices are in order and the budgeting amounts are adjusted as necessary for this expense. All other negative variances of the flexible budget for year nine are less that 5% and would not gain the attention of a manager using this method.